State officials urge changes to muni bond ratings

WASHINGTON, March 12 (Reuters) - State officials on Wednesday called on ratings agencies and lawmakers to eliminate a dual bond rating system that holds municipalities to a higher standard than corporate issuers, increasing borrowing costs for taxpayers.

The three major rating agencies should develop a unified rating system based on default risk, which in some cases could eliminate the need for bond insurance, California State Treasurer Bill Lockyer said in prepared testimony to the U.S. House of Representatives Financial Services Committee.

He said municipal bonds default far less often than corporate bonds, yet California cannot receive a triple-A rating.

"If the state of California received the triple-A rating it deserved, we could reduce taxpayers' borrowing costs by hundreds of millions of dollars over the 30-year term of the still-to-be issued bonds voters have approved to finance infrastructure development," Lockyer said in prepared remarks obtained by Reuters ahead of their release. "Billions of dollars more could be saved by municipal issuers across the country."

From 2003 through 2007, the state of California spent $102 million to insure $9.1 billion in general obligation bonds, he said.

He said a March 4 letter sent to ratings agencies, which urges them to devise a unified rating system, has been signed by 10 other state treasurers and four other state and local municipal issuers.

Connecticut Attorney General Richard Blumenthal, who also testified before the panel, said Congress should prohibit differing rating standards for corporate and municipal bonds and require fair and equitable treatment of all bond issuers.

"More specifically, federal law should prohibit credit rating agencies from assigning different credit ratings to bonds with similar rates of default and risk," he said in prepared testimony .

Blumenthal, who is investigating the legality of the dual ratings system, said there was no legitimate business reason for maintaining a "dangerously misleading and misguided" system that "imposes a secret Wall Street tax on states, cities and school districts across this nation."

He said ratings agencies have made a concerted effort to kill attempts at reforming the rating system in order to maintain process and prop up the market for bond insurance.

Pennsylvania Treasurer Robin Weissmann, also testifying before the panel, said Congress should allow municipal issuers an additional opportunity to refund their bonds to allow them to switch from variable rate debt demand bonds to fixed rate debt.

Weissmann also said the SEC should alter the ratings requirement for its Rule 2a-7, which governs qualified investment in money market mutual funds and requires them to hold investments rated double-A or better. But under current standards, a municipal bond with the same default risk as a double-A corporate bond won't achieve the same rating.

"Applying corporate-equivalent standards to municipal bonds and altering the rating requirement of Rule 2a-7 would expand the market for tax exempt money market funds, benefiting both issuers and investors," Weissmann said. (Reporting by David Lawder and Patrick Rucker, Editing by Chizu Nomiyama)